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Instrument rules in monetary policy under heterogeneity in currency trade

We embed different instrument rules into a New Keynesian model for a small open economy that is augmented with technical trading in currency trade to examine the prerequisites for monetary policy. Specifically, this paper focuses on conditions for a determinate, least-squares learnable rational expectations equilibrium (REE). Under an interest rate rule with only contemporaneous macroeconomic data, the intensity of technical trading or trend-seeking in currency trade does not affect these conditions, except in the case of an extensive use of trend-seeking. On the other hand, if the central bank uses only forward-looking information in its interest rate rule, a determinate and learnable REE is a less likely outcome when trend-seeking in currency trade becomes more popular. The interest rate rule followed by the central bank in the model incorporates interest rate smoothing.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0722netti.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 22/2007.

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Length: 29 pages
Date of creation: 20 Nov 2007
Date of revision:
Handle: RePEc:hhs:bofrdp:2007_022
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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